Auctions Versus Negotiations in Procurement: An Empirical Analysis
Robert S. McMillan
Revised October 2002 When should a buyer award a procurement contract through competitive bidding, and when would negotiating with the sellers be preferred? To shed some light on this question, we examine a unique data set of non-residential, private sector building contracts awarded in Northern California during the years 1995-2000. Our analysis suggests a number of limitations to the use of auctions, as compared to negotiations, that we believe are new to the literature. First, auctions perform poorly when projects are complex and contractual design is incomplete. Second, the benefits to auctions fall when the number of available bidders decreases. Third, auctions stifle communication between the buyer and the contractor, preventing the buyer from taking advantage of the contractor’s expertise when choosing how to design the project. Finally, auctions fail to protect the privacy of the buyer and involve increased administrative expenses and delay. Working Papers Index
Should the buyer of a customized good use competitive bidding or negotiation to select a contractor? To shed light on this question, we offer a framework that compares auctions with negotiations. We then examine a comprehensive data set of private sector building contracts awarded in Northern California during the years 1995-2000. The analysis suggests a number of potential limitations to the use of auctions. Auctions perform poorly when projects are complex, contractual design is incomplete and there are few available bidders. Furthermore, auctions stifle communication between buyers and the sellers, preventing the buyer from utilizing the contractor's expertise when designing the project. Some implications of these results for procurement in the public sector are discussed.
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